After over around 6 months of closely monitoring Lending Club’s activity we have observed that it behaves as a borrower’s market.
Marketplace Lending (platforms that do disintermediate banks by connecting investors with loan seekers) is going to be in 2015 between 1 and 2% of consumer credit in the US. And it is growing at 100% per year. So if we do a very simple math, we can conclude that in less than 10 years it will take 10% of the consumer credit market in the US away from banks. And now we are talking real money…This is the time when banks will begin to lobby to increase the regulation of these new players that take advantage from not having deposit takers, and therefore be subject to a very light regulation.
Why does it grow so much? The reason varies by geography, but overall it can be reduced to two main reasons on the loan seeker side:
- It is cheaper for the loan seeker. This is specially true in the US, where marketplace lending is basically a proxy for revolving credit cards and loan consolidation. How much cheaper? In the order of 5-10% (500 to 1.000 bps) per year, depending on the credit profile. Definitely a very good reason for a loan seeker to change from a bank to a lending platform.
- It is faster than a bank and more convenient. This is specially true for the UK where banking regulation, KYC processes and legacy score systems make the loan process extremely cumbersome. A normal bank, if it does not know the client can take anything from a week to well over a month. In marketplace lending, platforms can grant a loan in anything from a few minutes to a little over a week.
But why it grows so much on the investor side? The reason is basically the stability of returns across the interest rate cycle, and the extra interest that investors are getting for comparable risk.
On the stability of returns, we can see the chart below. We have built a theoretical marketplace lending asset class index (composed of the main lending platforms in the US and UK weighted by their size) and we can see that as interest rates go down, returns for marketplace investors remain stable.
Marketplace Lending Asset Class Profitability
Also, I can argue that the average investor is buying a B4 years type of bond when he buys on a diversified way a basket big enough of loans (since our market place lending index yields an average 4-5% delinquency ratio per year), see chart 2 below. Under this scenario, we can also see that market place lending is yielding 1-2% per year extra interest for the same risk. No wonder investors are buying it…
Global Bond Default Ratios in the 20th Century
Another topic is how to measure correctly profitability of the marketplace lending platforms. But that will be part of another post.